Untamable, Overlapping Electric Power Markets

As a commodity, electric power has always has been a difficult trade. To simplify, investors used independent power producers as their proxy to the power markets. They could be making a mistake.

Unlike oil and natural gas, where West Texas Intermediate and Henry Hub are frequently used as benchmarks, North American power markets offer no national clearing price. Several attempts have been tried; all failed.

The reason is there are at least twelve separate and uncorrelated markets: Ten formal markets and at least two informal markets. Some could even argue there are dozens more informal markets. But when all markets are combined, there is no single number, which can represent a national price for power.

The inability to integrate the markets is attributed to the markets' designs. Each power market was built organically in the 1990s. While general principles were consistent among the markets, specific rules varied by region. Each region had unique ideas on how to trade the commodity and how to manage reliability. As a result, it is nearly impossible to create a national market.

The ISO/RTO Council (IRC) offers a snapshot of North American power markets. IRC provide a map that illustrates current geographic locations of the six US markets, the combined US-Canadian market and the three Canadian markets. They also show vast regions in the nation's southeast and western regions where there are no formal markets. What they don't show is the expected expansion of one market in the Midwest. Nevertheless, the map illustrates the challenge; it's impossible to derive a national clearing price for power.

To make matters even more confusing, a separate group called North American Electric Reliability Corporation (NERC) also divided the national power markets. NERC's design addresses reliability challenges, not commodity markets. As such, NERC divided the nation differently (see their map) but utilities often interchange NERC and IRC designations.

Most investors ignore market details and jump into positions with their favorite national power producers like Calpine (CPN), NRG Energy (NRG), GenOn Energy (GEN), Dynegy (DYN), Exelon (EXC) and Entergy (ETR). Most are unaware all of these producers straddle more than one power market. As such, when investors bet on a specific company, they have also been betting on power market combinations.

A good example is Calpine. As their NERC-based map indicates, they are producing power in all U.S. power markets, including several informal markets. An investment in Calpine is, among other things, an investment all the national power markets.

Like Calpine, NRG Energy has a multi-market footprint. While not as expansive, NRG operates in six separate power markets (California, Texas, Midwest, PJM, New York and New England) and one informal market (Arizona and Nevada). They own a minority interest in a coal plant in Australia. They also are in the process of acquiring GenOn Energy.

GenOn operates in the same markets as NRG plus one additional market. GenOn has 1,317 megawatts in the Southeast, which includes Mississippi, Alabama and Florida. The have substantial presence in California and PJM (covering the Mid-Atlantic States). Merging GenOn assets with NRG does not materially alter NRG's footprint, but it certainly complements their strategy.

Dynegy competes with NRG in California and New York. It has a small presence in PJM and New England. They have a significant presence in Illinois, which are mostly coal units operating in the Midwest power market (MISO).

Exelon's independent power subsidiary operates nationwide, but 92% of its capacity is nuclear. Exelon's nuclear assets operate primarily in PJM, with additional assets in New York and the Midwest. In Exelon's case, it is important for investors to appreciate that the eastern side of the power markets behave differently from the Midwestern. Eastern submarkets have higher gross margins than Midwestern locations.

Entergy's independent power subsidiary operates primarily in Louisiana, Arkansas, New York and New England. Entergy owns the nation's second-largest fleet of nuclear power plants, some of which remain fully regulated and are not subject to market conditions. Their deregulated fleet operates in New York and New England and they depend heavily on New York and New England power markets.

Not only are investors exposed to the risks of multiple markets, they are also exposed to a variety of fuel strategies. Calpine is a pure play on natural gas in multiple power markets. Exelon is a play on nuclear power generation in eastern markets. NRG owns a basket of generators, including nuclear, and they represent a play in multiple markets. Dynegy relies on Midwestern coal.

Do not oversimplify the independent power business. Before making an investment or analyzing performance, make sure there is a clear understanding of the company's strategic position.